"We find weak price competition in a number of areas of the asset management industry. Firms do not typically compete on price, particularly for retail active asset management ...our additional analysis suggests that there is no clear relationship between charges and the gross performance of retail active funds in the UK.” These are direct excerpts from the FCA’s recent asset management market study.
In most other industries, the solution to all this is a discerning customer base – clients who vote with their feet, allowing for new entrants, product innovation and fee differentiation based on their concept of value for money. So why is this still not happening in our industry, where parts of it do not appear to compete on price or value for money?
A common response is that the average end customer is undereducated in finance, finding our industry mystifying and complex. And as the saying goes, where there is mystery there is margin. Is customer education the solution? At first blush, it seems so. A sophisticated customer base should be more discriminating and less accepting of poor outcomes, and would therefore encourage competition and transparency. But not so fast.
A recent study by Andriy Bodnaruk and Andrei Simonov explored this exact question. In their paper ‘Do financial experts make better investment decisions?’, they evaluated the private investment portfolios and decisions of investment experts and compared them with the lay person. This is what they found: “We find no evidence that financial experts are making better investment decisions: they do not outperform, do not diversify their risks better, and do not exhibit lower behavioural biases. Overall, our results demonstrate that (for highly sophisticated investors) expertise in finance does not improve investment decisions.”
These findings are not that surprising. For a start, investing is difficult and complex and there is no right answer – and the degree of randomness acts as a great equaliser. Also, specialists struggle because they place a higher premium on their own knowledge, when they probably end up believing in themselves more than they should. Equally, education cannot solve for the very destructive emotional biases we all have of investing after prices have risen, and selling after they have fallen.
We also see how experts struggle to add value, when education is not the problem. We have recently written, for example, how we find very few managers adding value through asset allocation, yet the teams informing these decisions are some of the most financially literate. Equally, the FCA study finds how investment consultants struggle to evidence added value to clients and they, too, are highly sophisticated. Education is certainly no guarantor of good decision making in investments.
How, then, do we improve end client investment decisions, and thereby benefit industry-wide competition and transparency? We have no perfect answer here, although we are sceptics of the consumer education argument. We are also doubtful of whether fund managers would introduce their own measures to increase competition and vary their margins.
The regulator has played such an important role of late because it is highlighting all the conflicts and shortcomings of our industry. While this is hard to face up to, having the dirty laundry out in the open has been great for champions of transparency and improved customer outcomes.